- What's in this article:
- Jackson Hole recap
- Whipsawing trade
- Macro stabilization?
- Gold ascendant
- Jackson Hole recap:
- The annual Jackson Hole summit provided an important forum for U.S. Federal Reserve (Fed) Chair Powell on the debate concerning the path of U.S. monetary easing going forward.
- Powell failed to fully endorse market expectations for aggressive rate cutting. Instead, the Fed signaled its intent to maintain flexibility going into the September 18 rate decision, and highlighted that financial conditions had improved, helping to sustain the growth outlook. Powell continues to view the mid-cycle slowdowns of 1995 and 1998 as the correct points of comparison, rather than taking his cue from more recent easing cycles that snowballed into recessions.
- To be sure, rate cuts remain the default assumption and Powell acknowledged “significant” downside risks to the base-case outlook. Furthermore, the dovish phrase from the most recent FOMC meeting was reiterated: “we will act as appropriate to sustain the expansion.”
- Providing something of a rebuttal to recent criticism of Powell by President Trump, Powell indicated that monetary policy cannot solve the problem of tariffs.
- The academic presentations delivered alongside those of monetary policy practitioners also contained some interesting claims/findings. The one attracting the most attention – including a citation from Powell – was co-authored by Larry Summers and argued that the neutral interest rate is even lower than conventionally thought, with bond bullish/monetary policy dovish implications.
- We continue to budget for a handful of additional 25bps cuts by the Fed through the remainder of 2019.
- Whipsawing trade:
- The U.S.-China trade story continues to whipsaw, with the mood flipping back and forth between pessimistic and optimistic on what seems like a daily basis.
- Friday August 23 was a bad day:
- China announced the application of new 5% to 10% tariffs on $75 billion of U.S. products, spanning 5,078 distinct items that include pork, soybeans, nuts and small aircraft. Beijing also restored tariffs on U.S. cars and car parts after having halted these last December. This represented China’s formal retaliation after the U.S. announced its plan in early August to levy tariffs on a further $300 billion of Chinese products. The Chinese magnitudes were largely in-line with expectations.
- The U.S. White House, in turn, responded to China in three ways:
- First, President Trump announced an increase in the tariff rate on various Chinese products. The roughly $250B of Chinese products already hit by U.S. tariffs will see their tariff rate increase from 25% to 30% as of October 1.
- Second, the roughly $300B in Chinese products set to be hit by tariffs later this year will encounter a higher tariff rate than previously planned: a 15% rate rather than merely 10%. Some of this round of tariffs will begin on September 1, and some on December 15.
- Third, President Trump said via Twitter that “our great American companies are hereby ordered to immediately start looking for an alternative to China”. In practice, the U.S. president does not have the authority to force companies to exit China short of declaring a national emergency. Trump had previously threatened to declare a national emergency to help facilitate the financing of his desired wall with Mexico, but did not ultimately follow through. Surveys suggest that U.S. firms are already busy shifting production out of China and toward Southeast Asia and Mexico.
- Last weekend then alternated between good and bad: President Trump first indicated at the G7 meeting in France that he was having “second thoughts” about the trade war with China. But, later, the White House issued a statement that claimed precisely the opposite – that if the President regretted anything, it was that he hadn’t increased China’s tariffs by even more.
- Monday August 26 then took a turn back to the positive, with a comment from the White House that discussions had taken place between the U.S. and China on Sunday night, which President Trump described as “much more meaningful than at any time.” Confusingly, China at least initially denied that any discussion had taken place.
- What to make of all this? We remain skeptical that the United States and China will manage to secure an enduring, comprehensive agreement. The two parties remain quite far apart on key issues. Short of one country simply abandoning its position in response to economic woes and/or financial-market weakness, we budget for the disagreement and associated tariffs to persist for some time.
- Fortunately, the latest tariff actions don’t significantly move the economic needle. China’s action had already been signaled. Meanwhile, the effect of the United States increasing its tariff rate by 5 percentage points might subtract another 0.1ppt—0.15ppt from U.S. and Chinese growth over the next few years – not trivial, but not a radical deviation from prior expectations.
- Elsewhere on the international relations file, there were a few constructive developments:
- The United States and France were said to come to an agreement over a tech-sector tax that France plans to apply to large international technology companies (prominently, major American firms). The tax may ultimately be superseded by something the OECD is working on to address the difficulty of taxing digital services within any one national jurisdiction.
- Meetings at the G7 were also said to have resulted in a high-level trade agreement between the U.S. and Japan. Details are not yet finalized. In some ways, the tentative accord resembles the CPTPP trade deal that President Trump pulled out of as one of his first acts as President. For instance, the United States gains more access to the Japanese agricultural sector. Japan will apparently also buy more corn to fill the void left by China. For its part, Japan manages to avoid paying a higher tariff on Japanese cars sold in the United States, at least for the moment.
- Macro stabilization?
- The main economic story remains one of slowing growth ever since the beginning of 2018.
- However, little vibrations occasionally perturb the downward economic path. So far, these have subsequently vanished as quickly as they arrived. But it is not impossible that any one might prove to be a turning point. After all, for all of the economic headwinds facing the world, the cumulative drag is not obviously enough to induce an outright recession.
- With this possibility in mind, we flag the fact that a handful of economic indicators have recently turned higher:
- U.S. core capital goods orders have now risen for three consecutive months. In theory, this acts as a leading indicator for U.S. manufacturing activity.
- Canada’s Markit manufacturing purchasing manager index (PMI) recently rose for a second-straight month.
- Japan’s manufacturing and service PMIs both rose in the latest month.
- The U.K. manufacturing, service and construction PMIs all rose in the latest month.
- The Eurozone composite PMI managed to rise in August.
- The global service-sector PMI rose for a second-straight month.
- To be clear, many other metrics continue to descend, ranging from the U.S. ISM manufacturing and non-manufacturing indices to the global manufacturing PMI. But the decline feels somewhat less broadly-based than in the past.
- It remains to be seen whether this tentative revival represents an important inflection point emboldened by central bank stimulus, or is instead just the latest blip along the path of decelerating growth. It is more likely the latter, but would be enormously consequential if it proves to be the former.
- Gold ascendant:
- The price of gold has hit a six-year high of US$1528/ounce, a sharp 26% higher than one year ago.
- Gold is influenced by a variety of macro-economic factors, including the expected rate of inflation, central bank actions, the degree of risk appetite in the market, and the level of bond yields.
- Of these, inflation is not particularly supportive of high gold prices: inflation expectations are tame and realized inflation is tame.
- That said, the other variables are all presently supportive of gold.
- Central banks, led by the U.S. Federal Reserve, have pivoted toward monetary stimulus – historically a time when gold appreciates on expectations of faster money supply growth.
- Risk aversion has increased over the past year as concerns about slowing growth, protectionism and an aging business cycle have mounted. This has been positive for gold prices.
- Lastly, bond yields have fallen significantly over the past few months. This is arguably the result of the aforementioned factors – dovish central banks and risk aversion in financial markets – though lower yields have a further bullish implication of their own in that a low-yield environment reduces the counterfactual cost of holding (yieldless) gold relative to bonds.
- Indeed, the correlation between gold and interest rates has been quite high over the past decade, and was also a significant contributor to the rally in gold over the first decade of the millennium as interest rates experienced a structural decline.
- Going forward for gold, then, much depends on how interest rates play out from here. Further monetary stimulus is quite likely, although already largely priced into the market. The risk is perhaps that central banks don’t deliver quite as much as the market would like, potentially tarnishing gold. However, this is not a strongly held conviction, particularly at a time when the business-cycle looks increasingly weary.
- Another consideration for gold prices is that they are historically quoted in U.S. dollars. Even if the global average price had not changed, a stronger dollar will give the appearance of a gold rally, and vice-versa. Some of the recent rally has been related to this phenomenon, though hardly all. Again, the outlook is blurry: our base-case outlook is for a softer dollar over time – positive for gold in U.S. dollars – although the end of the business cycle would presumably result in a safe-haven rally for the dollar.
- Gold flows don’t appear to be especially central to the determination of gold prices at present. The Russian and Turkish central banks have been accumulating gold, but central bank actions have not historically been a good predictor of gold prices.
- Precious metals such as gold trade very differently than do base metals. Industrial metals are well off their early 2018 highs, and have again been on a downward trend over the past few weeks. This relates to concerns about demand that link back to slower economic growth.